Market intelligence: China polyethylene sentiment shifts downward

What a difference three months can make. Back in December 2012, polyethylene (PE) traders were reportedly stocking up "like crazy" in anticipation of a bumper year in the Chinese market.

The assumption was that the economic recovery of late 2012 and January 2013, which was the result of perhaps politically motivated stimulus spending, would continue throughout this year.

But, as one Singapore trader describes, the outlook has radically shifted. China's demand for PE is even lower than immediately ahead of the Lunar New Year, which took place in mid-February, he said.

"For demand to be less than just before the New Year, when most traders had already pulled out of the market to avoid cargoes being stranded at ports during the holiday period, is remarkable. In the 10 years I've been in this business, this has never happened before," he said.

"Trading has come to a virtual halt and re-exports have increased," the trader noted. Re-exports comprise resin shipped to China and held in bonded warehouses. When that resin fails to find a home in the domestic market, it is shipped to other countries.

"I got it wrong as I thought there would be a strong recovery after the holidays, but it didn't happen because of policy uncertainty," said the trader. "Most other traders are in the same position. We all thought monetary conditions would remain favourable."

Managements of companies attending Susquehanna International Group's 2013 Chemicals Conference in Boston, Massachusetts, on 14-15 March also noted the disappointing near-term market conditions in China.

"Chinese economic recovery has not rebounded as fast as expected post the Lunar New Year and the managements of the companies attending our conference were somewhat surprised that the new Chinese political leadership has not taken more aggressive steps to stimulate the economy," said analyst Don Carson.

"Restrictions on the property market, reduced liquidity in the banking system and lower new lending in February have reduced PE buying," said the Singapore trader. "People are worried that Beijing will have to take more measures to cap property prices, as what has happened so far is unlikely to work. They think that eventually interest rates will have to be increased because overall inflation is also rising. This is further dampening activity."

TAPPING DOWN INFLATION

But while the People's Bank of China (PBOC) is keen to take a more aggressive stance on inflation, government agencies, such as the National Development and Reform Commission, are eager to maintain the recovery, said an 11 March Reuters article.

February inflation was, however, at 3.2%, up from 2.0% in January and close to the government's maximum annualised target of 3.5%.

The risk is that if the cost of living continues to rise at this pace, the PBOC might win the battle, leading to an increase in interest rates earlier than the fourth quarter, the current consensus forecast.

"A rise in interest rates would be a major blow to the market," said the trader. And even if pro-growth government agencies get their way for most of this year, the PBOC looks set to continue its policy of reducing liquidity as a tool to fight inflation.

A further reason to expect less credit in the system is that overall lending for January-February is ahead of the central bank's annualised target.

"Take January and February together and new loans are being extended at a [yuan (CNY)] 10tr [$1.6tr] rate for the year [on an annualised basis], well above the CNY8.5tr-9tr that Wang Jun, senior economist at the well-connected China Centre for International Economic Exchanges, believes the PBOC is tasked with for 2013," said Reuters.

Measures to control the shadow-banking system also seem likely. Total new credit, including loans through the informal or shadow-banking system and official lending, hit an all-time high in 2012.

The positive news about the above influences on inflation is that they are within China's means to control.

But another factor behind the rising cost of living - the surge in global oil prices - is beyond China's control, unless it raises subsidies on fuel prices.

"Today, gasoline is at CNY9,630/tonne and diesel at CNY8,810/tonne compared to June 2008's peaks of CNY6,980/tonne and CNY6,520/tonne," said Paul Hodges, chairman of UK-based chemicals consultancy International e-Chem in a 13 March post on his ICIS blog, Chemicals and the Economy.

"China's gasoline price for 90 RON [grade] is thus $4.60/gal [$1.20/litre] compared to current US prices of $3.75/gal. European prices are even higher at $8.00-$9.00/gal," he added.

"The mood in China's PE market is very pessimistic at the moment," said an Asia-based source with a North America-headquartered polyolefins producer.

"Traders were stocking up like crazy in December and January because they thought the recovery would last. At one point before the Chinese New Year, some of them had more than a month's worth of inventory, compared with the usual two weeks," the source said. "They have, as a result, been offloading material to minimise their losses, but I haven't heard of any re-export trade from China, although it seems possible."

Traditionally, the Chinese market has saved the world, but the source added: "Whilst prices are rising in the US right now, they are falling in China."

China's PE spot prices across all of the grades fell by $5-40/tonne during the week ended 15 March. This marked the third week in a row of declining prices.

"We are not only facing a period of weak demand, but also one of increased supply," said the polyolefins producer. "Middle East turnarounds are coming to an end in April-May and new capacity is starting up."

But it is not all doom and gloom. Despite the likelihood that China's overall growth in polyolefins demand will again be less than the increase in GDP in 2013, some segments of the business are doing very well.

"Demand growth from higher-value converters - for example, those producing high moisture-barrier PE film - remains excellent. It is in the high single digits," said a source with a second producer. "These converters are now very successfully taking on the Europeans because they have become very sophisticated. They are producing excellent quality films as a result of high degrees of technical knowledge. And they are very cost-efficient because of investment in automation."